Inventory management techniques

In this section we will explore the most common inventory management techniques used by businesses of all sizes — along with the inventory holding costs and potential profits of the most prominent.

Keep in mind that you’ll probably need a mix of different techniques to develop the most comprehensive strategy for your business.

1. Bulk shipments

This method banks on the notion that it is almost always cheaper to purchase and ship goods in bulk. Bulk shipping is one of the predominant techniques in the industry, which can be applied for goods with high customer demand.

The downside to bulk shipping is that you will need to lay out extra money on warehousing the inventory, which will most likely be offset by the amount of money saved from purchasing products in huge volumes and selling them off fast.

Pros of bulk shipments

Highest potential for profitability

Fewer shipments mean lower shipping costs

Works well for staple products with predictable demand and long shelf lives

Cons of bulk shipments

Highest capital risk potential

Increased holding costs for storage

Difficult to adjust quickly when demand fluctuates

2. ABC inventory management

ABC inventory management is a technique that’s based on putting products into categories in order of importance, with A being the most valuable and C being the least. Not all products are of equal value and more attention should be paid to more popular products.

The key is to operate each category separately, particularly when selective control, allocation of funds, and human resources are required.

Pros of ABC inventory management

Aids demand forecasting by analyzing a product’s popularity over time

Allows for better time management and resource allocation

Helps determine a tiered customer service approach

Enables more accurate inventory optimization

Fosters strategic pricing

Cons of ABC inventory management

Could ignore products that are just starting to trend upwards

Often conflicts with other inventory strategies

Requires time and human resources

3. Backordering

Backordering refers to a company’s decision to take orders and receive payments for out-of-stock products. It’s a dream for most businesses but it can also be a logistical nightmare … if you’re not prepared.

When there’s just one out-of-stock item, it’s simply a case of creating a new purchase order for that one item and informing the customer when the backordered item will arrive. When it’s tens or even hundreds of different sales a day, problems begin to mount.

Nonetheless, enabling backorders means increased sales, so it’s a juggling act that many businesses are willing to take on.

As a general rule, the bigger the item value (physically and monetarily), the more “delivery tolerance” you get from customers.

If you’re a small retailer, it may not be feasible to risk overstocking. In this case, you might consider labeling the item’s “Buy now” button as “Pre-order” or “Get yours when it comes back in stock.” This creates a reasonable expectation for customers that it will take a bit longer to arrive.

Alternatively, some businesses run with a “no-stock” approach which involves taking only backorders until they’ve generated enough sales to then place a large bulk in order with a supplier.

Pros of backordering

Increased sales and cash flow

More flexibility for small businesses

Lower holding costs and lower overstock risk

Cons of backordering

Higher risk of customer dissatisfaction

Longer fulfillment times

4. Just in Time (JIT)

Just In Time (JIT) inventory management lowers the volume of inventory that a business keeps on hand. It is considered a risky technique because you only purchase inventory a few days before it is needed for distribution or sale.

However, it also requires businesses to be highly agile with the capability to handle a much shorter production cycle.

If you’re considering adopting a Just in Time inventory management strategy, ask yourself the following:

Are my suppliers reliable enough to get products to me on time every time?

Do I have a thorough understanding of customer demand, sales cycles, and seasonal fluctuations?

Is my order fulfillment system efficient enough to get orders to customers on time?

Does my inventory management system offer the flexibility needed to update and manage stock levels on the fly?

Pros of JIT

Lower inventory holding costs

Improved cash flow

Less deadstock

Cons of JIT

Problems fulfilling orders on time

Minimal room for errors

Risk of stockouts

5. Consignment

Consignment involves a wholesaler placing stock in the hands of a retailer, but retaining ownership until the product is sold, at which point the retailer purchases the consumed stock. Typically, selling on consignment involves a high degree of demand uncertainty from the retailer’s point of view and a high degree of confidence from the wholesaler’s point of view.

For retailers, selling on consignment can have several benefits, including the ability to:

Offer a wider product range to customers without tying up capital

Decrease lag times when restocking products

Return unsold goods at no cost

While most of the risk in selling on consignment falls on the wholesaler, there are still a number of potential advantages for the supplier:

Test new products

Transfer marketing to the retailer

Collect useful information about product performance

If you consider selling on consignment — as either a retailer or wholesaler — set terms clearly regarding the:

Return, freight, and insurance policies

How, when, and what customer data is exchanged

Percentage of the purchase price retailer will be taking as sales commission

6. Dropshipping and cross-docking

This inventory management technique eliminates the cost of holding inventory altogether. When you have a dropshipping agreement, you can directly transfer customer orders and shipment details to your manufacturer or wholesaler, who then ships the goods.

Essentially, it means you move goods from one transport vehicle directly onto another with minimal or no warehousing. You might need staging areas where inbound items are sorted and stored until the outbound shipment is complete. Also, you will require an extensive fleet and network of transport vehicles for cross-docking to work.

7. Inventory Cycle counting

Cycle counting or involves counting a small amount of inventory on a specific day without having to do an entire manual stocktake. It’s a type of sampling that allows you to see how accurately your inventory records match up with what you actually have in stock.

This method is a common part of many businesses’ inventory management practices, as it ultimately helps ensure that customers can get what they want, when they want it, while keeping inventory holding costs as low as possible.

Pros of cycle counting

More time- and cost-efficient than doing a full stocktake

Can be done without disrupting operations

Keeps inventory holding costs low

Cons of cycle counting

Less comprehensive and accurate than a full stocktake

May not account for seasonality

Best practices for conducting an inventory count

How often you do a cycle count and how much stock you count will depend on the types of products you sell and the resources at your disposal. For example, you might do an ABC inventory analysis to determine your class A products, and do a cycle count on your most high-value items more frequently than your other items.

Regardless of your specific approach to inventory counts, here are some best practices to follow:

Count one category at a time – Ideally, you want to be able to cycle through your entire inventory on a period basis. It’s best to focus on one category at a time so you can count efficiently during business hours and not be impeded by operational downtime.

Choose count categories based on seasonality – The aim of inventory counting is to be able to rectify any disparities in inventory as and when they happen. It’s best to count products when they’re at their peak to ensure you can fix any issues immediately.

Mix up your cycle count schedule – It’s an unfortunate reality that inventory shrinkage is sometimes due to staff theft, so aim to vary your schedule to deter employees from “gaming the system.”

Types of inventory cycle count procedures

There are three main types of inventory cycle counts that you can use:

Control group cycle counting – This type of cycle counting focuses on counting the same items many times over a short period. The repeated counting reveals errors in the count technique, which can then be rectified to design an accurate count procedure.

Random sample cycle counting – If your warehouse has a large number of similar items, you might randomly select a certain number of items to be counted during each cycle count. This helps reduce the disruption of any one category at once, meaning you can carry out a count during business hours.

ABC cycle counting – As mentioned above, ABC cycle counting uses the ABC inventory management technique and Pareto principle to classify items in A, B or C categories based on value. With this approach, A items are counted more frequently than B and C items.

Inventory cycle counting in the real world

Using the company’s proprietary inventory system, on-site logistics managers can view their store’s stock levels and monitor any discrepancy in expected sales (unique to each store) versus inventory levels.

For example, let’s say that IKEA’s MALM bed frame has been selling much slower than expected. In this case, the logistics manager can manually check and confirm the stock of the bed frame. This means logistics managers only need to cycle count if the system catches a discrepancy.